What’s to come?

For those interested in stats, another record is about to be challenged: the longest-running period without a 5% fall for the S&P 500.

The record stands at 394 working days, set as the dotcom bubble began to inflate in the late 1990s. During the current cycle, it has so far managed 386 days, helped no doubt by rock-bottom volatility. Will this continue? The US Federal Reserve is expected to increase the pace of its interest rate hikes this year, especially now that the US tax cut is law. And the Fed is no longer the only major central bank that is expected to tighten monetary policy: upbeat European economic data may lead to a faster unwinding of the Continent’s ultra-loose interest rates and quantitative easing programme. Even Japan’s much-maligned economy has been looking much healthier lately, potentially paving the way for a reduction in its mind-boggling level of monetary stimulus.

Tighter policy around the world would mean higher discount rates and therefore less valuable future cash flows. Still, central banks have been very cautious when raising rates since the financial crisis (except for that regrettable episode with the European Central Bank – under a different boss – in 2011). If this wariness continues, it seems likely tighter monetary policy will be accompanied by decent economic growth, which should feed corporate revenue growth. As more valuation components move in different directions, greater volatility could be in the pipe for both bond and equity markets.

Can equity markets post another year of double-digit returns? Only a brave investment manager would have told clients at the start of 2017 that the year would produce close to the best annual returns for global equites since 2009. By year end, the FTSE World index was up 21% in dollar terms (although in sterling it’s much less because of a strengthened pound), having delivered 14 months of advances. So far, the S&P 500 has delivered 2.6% in dollar terms, the strongest start since 2013. The economic backdrop looks pretty good. Last year, two-thirds of the 25 largest economies grew faster than their long-run averages and the IMF believes that should continue in 2018.

As we come off a strong year, many dream of another soaring uplift this year. Our fingers are definitely crossed. However, we feel it’s more prudent to prepare for a rockier investment landscape. Barring a sudden global downturn, equities should offer adequate returns – better than bonds, at least. But expectations should be tempered, lest irrational exuberance get the better of us.

  Index 1 week 3 months  6 months 1 year FTSE All-Share 0.6% 3.8% 7.1% 12.8% FTSE 100 0.5% 3.6% 6.7% 11.7% FTSE 250 1.0% 4.7% 9.0% 17.5% FTSE SmallCap 1.1% 3.8% 8.5% 18.4% S&P 500 2.4% 4.5% 8.2% 12.3% Euro Stoxx 3.1% 1.4% 7.2% 20.3% Shanghai SE 2.7% 2.6% 5.7% 4.1% FTSE Emerging Index 3.3% 5.1% 14.0% 23.4%

Source: FE Analytics, data sterling total return to 5 January

Pause or problem?

The FTSE All-share hit a new record in the first week of January too, but it’s still the laggard.

At 4,246, the benchmark index was up just 0.6% last week. A pall seems to hang over the UK market. It is benefiting from the global uplift, but something is weighing on the market. It’s unclear whether it’s Brexit uncertainty, worries about Labour taking power and radically shifting policy or simply lacklustre economic data. Perhaps it’s a mix of all three – perhaps it’s something else entirely.

The amount UK households spend in shops took a noticeable step downward last year, so the Christmas trading results will be a decent signal about whether Brits are confident enough to splurge a bit more. Those retail sales numbers won’t be out till next Friday, but economists aren’t expecting much: just 0.6% higher than last December is the forecast. UK new car registrations were more than 14% lower in December than a year earlier. That was exaggerated because it was off the back of record sales in 2016. Last year was a gloomy year for car sales, with each of the last nine months showing lower registrations. Still, it’s not a great omen for UK consumption, which drives the country more than anything else.

And the great bellwether for UK consumption is the housing market. Price growth has started to slow. The countrywide average fell in December for the first time since June. Again, it’s not as bad as it sounds: the annual growth for the three months to December was 2.7%. Still, there seems to be a bit of worry bouncing round the nation’s homes, and in many ways that’s more important than the absolute value of houses. These factors make us nervous about the UK, especially those companies that depend on economic growth to push through higher earnings.

In politics, Prime Minister Theresa May is apparently embarking on a reshuffle of her Cabinet this week. Her leadership circle has been badly ravaged by scandals and in-party fighting over the past year. The FT reports that Boris Johnson, Amber Rudd and David Davis are expected to remain in their posts, but the remainder could see an infusion of new personnel. Mrs May will have to be careful to placate both the hard-Brexit wing and the anti-Brexit faction of her party. Hopefully this political calculus won’t preclude some bold steps.

Bonds

UK 10-Year yield @ 1.24%
US 10-Year yield @ 2.48%
Germany 10-Year yield @ 0.44%
Italy 10-Year yield @ 2.00%
Spain 10-Year yield @ 1.52%

Economic data and companies reporting for week commencing 8 January

Monday 8 January

US: Consumer Credit (Nov)
EU: Consumer/Economic/Industrial Confidence (Dec), Services Confidence (Dec); GER: Factory Orders (Nov)

Half-yearly results: Micro Focus
 

Tuesday 9 January

US: NFIB Small Business Optimism (Dec)
EU: GER: Industrial Production (Nov), Trade Balance (Nov), Exports (Nov), Imports (Nov)

Quarterly production results: Ferrexpo
Trading update: Persimmon, Robert Walters, Wm Morrison
 

Wednesday 10 January

UK: Industrial Production (Nov), Construction Output (Nov), Trade Balance (Nov), NIESR GDP Estimate (Dec)
US: MBA Mortgage Applications, Import Price Index (Dec), Wholesale Inventories (Nov)
EU: FRA: Industrial Production (Nov), Manufacturing Production (Nov)

Trading update: J Sainsbury, Marks & Spencer, Page Group, Taylor Wimpey, Tullow Oil
 

Thursday 11 January

US: PPI Ex Food and Energy (Dec), Initial Jobless Claims
EU: Industrial Production (Nov); SPA: Industrial Output (Nov); ITA: Retail Sales (Nov) 

Trading update: Barratt Developments, Hays, Tesco
 

Friday 12 January

US: CPI (Dec), Retail Sales Ex Auto (Nov), Business Inventories (Nov)
EU: FRA: CPI (Dec); ITA: Industrial Production (Dec)

 

Julian Chillingworth
Chief Investment Officer